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By Paul Schott Stevens

June 16, 2015

Fund boards and independent directors have a long history of serving shareholder interests, yet today they face an alarming prospect that could threaten their ability to continue doing so. I refer to the possibility that funds or fund advisers might be designated as “systemically important financial institutions” (SIFIs) and thus subject to “enhanced prudential supervision” by the Federal Reserve Board.

SIFI designation and prudential supervision by the Fed could fundamentally alter the governance of regulated funds in the United States. Consider, for example, the implications of SIFI designation for governance of General Electric Capital Corporation.

Proposed Restrictions on GE Capital’s Board

We have written a number of ICI Viewpoints pieces about efforts by the U.S. Financial Stability Oversight Council (FSOC) to determine whether financial firms other than banks pose outsized risks to the financial system. Firms that the FSOC considers to pose systemic risk are designated as SIFIs under the Dodd-Frank Act and regulated by the Federal Reserve.

One of the firms that the FSOC has already designated is GE Capital. To provide specificity for its new oversight role, the Federal Reserve Board has proposed an extensive set of enhanced prudential standards for GE Capital, including unprecedented, highly prescriptive requirements for its board of directors. The Fed is still working through comments on its proposal—including comments from GE Capital itself—and we can’t be certain how its final rule will turn out. But we do know that what the Fed has proposed constitutes a remarkable intrusion on the existing governance arrangements of GE Capital as well as its parent, the General Electric Corporation.

What Might Fund Boards Face?

The Fed’s approach to governance derives from its experience with the largest global banks, and it seems intent on applying that governance template elsewhere. Its approach consists, first, of reshaping the composition of boards and effectively changing the loyalties of directors consistent with the Fed’s interests in prudential supervision; and second, of imposing on boards detailed new responsibilities and requirements that ultimately will need to be carried out to the Fed’s satisfaction.

More specifically, the Fed would require GE Capital to add two new outside directors who are not only independent of GE and GE Capital, but who also are independent of GE’s board and its outside directors. In practice, they also will need to meet the approval of the Fed. In effect, these directors would be loyal to the Fed and to its interests and objectives as a prudential regulator, not to the interests of GE’s shareholders or other stakeholders.

Similar mandates on fund boards could result in the seating of a wholly new class of independent directors—ones who are independent both of the fund’s adviser and of the fund’s current independent directors. This new class of independent directors would be hand-picked by the Fed, and would owe primary loyalties not to the fund or its investors but to the “prudential” objectives of the Fed. This conflicted model of fund governance would mirror the conflicted model of regulation that produced it. The “prudential market regulation” model envisioned by the Fed’s leadership for the fund industry would place the “demands” of the banking system above the interests of fund investors, and the regulatory objectives of the Fed above the fiduciary obligations of fund advisers and directors.

The Fed’s proposal goes even further, to add many duties for GE Capital’s directors. It envisions an independent board committee responsible for GE Capital’s risk-management policies—a new structure mandated by the Fed wholly outside the risk-management structures established by the management of GE and GE Capital. Other new duties include analyzing and approving risk-management policies; annually approving GE Capital’s liquidity-risk tolerance and ensuring that it operates within that tolerance; and reviewing the process for assessing capital adequacy in capital plans submitted to the Fed each year.

The upshot of all these new requirements is to place on the board responsibilities that arguably are better suited to management. This tension over the proper role for, and expectations of, a board is one with which the fund industry already wrestles under Securities and Exchange Commission regulation. It likely would become far greater under the “enhanced prudential supervision” of the Federal Reserve.

Ominous Implications for Fund Boards and Independent Directors

The Fed’s governance designs do not stop with its GE Capital proposal. As has been widely reported, the Fed’s supervisors have become a frequent presence at the board meetings of some of the largest U.S. financial institutions. And these supervisors are calling increasingly for boards to become involved in management duties that reach beyond the scope of—or are too granular for—directors’ traditional oversight role. According to the Wall Street Journal, the Fed’s approach has led some otherwise-qualified directors to question whether to serve on a board, so great are the concerns about second-guessing and personal liability.

Federal Reserve Board Governor Daniel K. Tarullo, the de facto head of regulatory policy at the central bank, advocates going much further. In a speech last year, he asked how corporate governance might be modified to align with “macroprudential” regulatory objectives. One way to accomplish this goal, Tarullo suggested, would be to “broaden the fiduciary duties” of boards—broaden them, that is, beyond the duties of loyalty and care traditionally owed to shareholders to include new loyalties to the banking system and, effectively, to the Fed.

For fund boards and independent directors, all this has an ominous quality—and raises serious questions. What happens when these differing interests collide? How would independent fund directors respond if the Fed were to direct that a fund’s portfolio investments be managed in a way that the directors or the fund’s adviser believed was not in the best interests of the fund’s shareholders?

These questions ought to concern us all. If the Fed succeeds in inserting itself into fund boardrooms, the long-term impact likely would extend well beyond any funds or advisers initially designated as SIFIs. The number of such SIFIs could well grow over time to encompass more and more complexes. And as new regulatory expectations of funds or asset managers emerge that are centered on banking “system demands,” they likely will not be satisfied until applied more broadly.

According to press reports, the board and management of GE have elected to exit the business and sell off most of its GE Capital subsidiary, thus possibly disentangling the parent company from the intrusive and burdensome Fed supervision that has come along with GE Capital’s SIFI designation. The answer for a fund or adviser may not be so simple, but one thing seems certain: designation would put the Fed in the driver’s seat, and put independent directors—and with them fund shareholders—in the back seat. It would upend a governance structure that has evolved over the past 75 years and today serves the interests of our shareholders very successfully.

As noted above, the GE Capital proposal is not yet final. But with funds and their advisers still at risk of SIFI designation, the Fed’s stated intentions have important implications—and high stakes—for all independent fund directors. ICI will continue to engage vigorously on this issue, and do everything we can to ensure that the Fed’s intentions don’t become reality. Fund boards—and fund shareholders—deserve nothing less.

SEC Chair White Affirms Agency Has Tools to Address Risks in Industry

By Rachel McTague

May 8, 2015

The U.S. Securities and Exchange Commission (SEC) has the tools it needs to address systemic risks to the extent they exist in the asset management industry, said SEC Chair Mary Jo White at the opening session on the final day of ICI’s annual General Membership Meeting (GMM). White also announced that David Grim—who had been serving as acting director of the SEC’s Division of Investment Management—has just been named director of the division. White said she is thrilled that Grim, a 20-year veteran of the SEC in the investment management area, is taking the reins at a time when the Commission is moving forward to implement proactive regulations for the industry.

Nooyi’s Purpose, Pepsi’s Performance

By Rob Elson

May 7, 2015

We all have a moral compass. But for PepsiCo’s Indra Nooyi, “the moral compass of our lives must also be the moral compass of our livelihoods.”

Stirring words from the company’s chair and chief executive—and just a few of the many she delivered in a lively Q&A with Vanguard Chairman and CEO Bill McNabb at ICI’s 57th General Membership Meeting, which began yesterday in Washington, DC.

Opinion: The Tax Threat to Your Mutual Fund

By Mike McNamee

May 7, 2015

Vanguard Chairman and CEO Bill McNabb sent “an open letter to all mutual fund investors” in the opinion pages of Thursday’s Wall Street Journal. His message: fund investors face a clear threat of higher costs, weaker returns, and a bailout tax to salvage other failing financial institutions—all if regulators get their way in imposing new rules on funds or their managers.

GMM Policy Forum: “It Always Comes Down to Trust”

By Todd Bernhardt

May 6, 2015

Over the 75-year history of the modern mutual fund industry, funds have helped to democratize investing, providing a tremendous array of investing options at a reasonable cost for millions of people. And given rapid advances in technology and the efficiencies that they can bring, the future looks even brighter, said Walter W. Bettinger II at the opening session of ICI’s 57th General Membership Meeting (GMM).

By Paul Schott Stevens

Designation’s Vast Reach into Investor Portfolios

By Paul Schott Stevens

March 24, 2015

On Wednesday, March 25, I’ll testify before the Senate Committee on Banking, Housing, and Urban Affairs about the Financial Stability Oversight Council’s process for designating nonbank firms as “systemically important financial institutions,” or SIFIs.

Living Wills and an Orderly Resolution Mechanism? A Poor Fit for Mutual Funds and Their Managers

By Frances Stadler and Rachel Graham

August 12, 2014

During the global financial crisis, the distress or disorderly failure of some large, complex, highly leveraged financial institutions (banks, insurance companies, and investment banks) required direct intervention by governments—including a number of bailouts—to stem the damage and prevent it from spreading. One focus of postcrisis reform efforts has been to ensure that regulators are better equipped to “resolve” a failing institution in a way that minimizes risks to the broader financial system, as well as costs to taxpayers. The new tools provided under the Dodd-Frank Act include requirements for the largest bank holding companies and nonbank systemically important financial institutions (SIFIs) to prepare comprehensive resolution plans in advance (known as “living wills”), and creation of a new “orderly resolution” mechanism for financial institutions whose default could threaten financial stability.

By Miriam Bridges

June 9, 2014

In conversations exploring outcome-oriented investing, the globalization of the fund industry, and the next generation of retirement plans, industry leaders offered their perspectives on serving investors in an evolving world during several insightful sessions at ICI’s annual General Membership Meeting, held in Washington May 20–22.

Now Off the Hill, Senator Snowe Still Brimming with Ideas, Advice

By Rob Elson

June 5, 2014

U.S. policy is ripe for reform in a number of key areas, but changes to ease the polarized political environment must come first, former U.S. senator Olympia Snowe (R-ME) told the crowd during the final session of ICI’s 56th annual General Membership Meeting (GMM), held May 20–22 in Washington, DC.

Industry Leaders Reflect on Serving Investors in an Evolving World

By Christina Kilroy

June 4, 2014

Speaking on the Leadership Panel held Wednesday, May 21, at ICI’s General Membership Meeting (GMM), fund industry leaders agreed that challenges as well as opportunities abound for their businesses in today’s complex world.

By Rachel McTague

May 22, 2014

Securities and Exchange Commission (SEC) Chair Mary Jo White today called for the U.S. Financial Stability Oversight Council (FSOC) to use outside expertise to the degree necessary in its process of designating systemically important financial institutions (SIFIs). She asserted that it is “enormously important for FSOC, before it makes any decision of any kind, to make sure it has the necessary expertise on any of those issues.”

By Todd Bernhardt

May 21, 2014

The fund industry needs to stop focusing on the moment and start focusing on outcomes when advising investors on their resources, said Laurence D. Fink, chairman and CEO of BlackRock, at ICI’s Annual Policy Forum, part of the Institute’s 56th General Membership Meeting (GMM).

America’s Retirement System Is Strong

By Sarah Holden

December 18, 2013

One year ago, ICI released its landmark study, The Success of the U.S. Retirement System, a compilation of research from a wide range of sources, which found that the country’s retirement system is fostering economic security in retirement for Americans across all income levels.

ICI’s Guide to Avoiding a Common 401(k) Tax Trap

By Mike McNamee

December 9, 2013

A tax trap for retirement savings is catching many smart people unaware. If allowed to go unchecked, it could harm the retirement savings of millions of Americans. A columnist for the Washington Post was just the latest in a long list of victims.

Marginal Tax Rates and the Benefits of Tax Deferral

By Peter Brady

September 17, 2013

Second in a series of posts about retirement plans and the policy proposals surrounding them.

In a previous Viewpoints post, I discussed the difference between tax deferral—the tax treatment applied to retirement savings—and tax deductions and exclusions, such as the mortgage interest deduction or the exclusion of employer-paid health insurance premiums from income. The difference is often overlooked or misunderstood, leading to inaccurate analysis and harmful policy proposals.

Retirement Plan Contributions Are Tax-Deferred—Not Tax-Free

By Peter Brady

September 16, 2013

First in a series of posts about retirement plans and the policy proposals surrounding them.

In today’s fiscal and political climate, taxes are never far from politicians’ minds. Whether to achieve comprehensive tax reform or to raise revenue to meet budget deficits, members of Congress are now considering changes to a range of tax code provisions—including those governing retirement policy. Any comprehensive effort to address fiscal policy or tax reform should examine every option, but some discussions of retirement policy have been misguided. The tax treatment of retirement savings—tax deferral— too often has been lumped together with tax deductions (such as the deduction from income of mortgage interest expense) and tax exclusions (such as the exclusion from income of employer-provided health insurance premiums).